Hearne Company has a number of potential capital investments. Because these proj

Question

Hearne Company has a number of potential capital investments. Because these projects vary in nature, initial investment, and time horizon, management is finding it difficult to compare them. Assume straight line depreciation method is used. Project 1: Retooling Manufacturing Facility This project would require an initial investment of $5,500,000. It would generate $982,000 in additional net cash flow each year, The new machinery has a useful life of eight years and a salvage value of $1,156,000. Project 2: Purchase Patent for New Product The patent would cost $3,855,000, which would be fully amortized over five years. Production of this product would generate $732,450 additional annual net income for Heane Project 3: Purchase a New Fleet of Delivery Trucks Hearne could purchase 25 new delivery trucks at a cost of S180,000 each. The fleet would have a useful life of 10 years, and each truck would have a salvage value of $6,300. Purchasing the fleet would allow Hearne to expand its customer territory resulting in $855,000 of additional net income per year Required: Determine each project's accounting rate of return. (Round your answers to 2 decimal places.) Project t Project 2 Project Determine each project's payback period. (Round your answers to 2 decimal places.) Project t Project 2 Project3

Explanation / Answer

Ans 1 Project 1 Project 2 Project3 Cash Inflows per year 982000 732450 855000 Less: depreciation 543000 771000 434250 Depriciation on SLM basis (5500000-1156000)/8 3855000/5 (4500000-157500)/10 Accounting profit A 439000 -38550 420750 Initial Investment I 5500000 3855000 4500000 Acccounting Rate of Return A/I*100 7.98 -1 9.35 % Ans 2 Payback Period Project 1 Project 2 Project3 Cash Inflows per year c 982000 732450 855000 Initial Investment I 5500000 3855000 4500000 Payback Period I/C 5.60 5.26 5.26 years Ans 3 Project 1 Project 2 Project3 Total present value of cash flows Cash Inflows C 982000 732450 855000 No.of years 8 5 10 Present Value of an Annuity of $1 at Compound Interest P for years PVIFA(I,n) 5.3349 3.7908 6.1446 P.V of Cash Inflows C*P 5238871.8 2776571.46 5253633 Salvage value 1156000 157500 Present Value of $1 at Compound Interest at end of life PVIF(I,n) 0.4665 0.3885 PV of salvage value 539274 61188.75 Total present value of cash inflows 5778145.8 2776571.46 5314821.75 Less: cash Outflow -5500000 -3855000 -4500000 NPV 278145.8 -1078428.54 814821.75 Ans 4 Project 1 Project 2 Project3 Profitability Index Total present value of cash inflows P 5778145.8 2776571.46 5314821.75 Initial Investment I 5500000 3855000 4500000 Profitability Index P/I 1.0506 0.7203 1.1811 Rank 2 3 1 If we see all Project 3 is the best option and than project 1

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